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Inching to Impact: the challenges of charities in impact investing

Inching to Impact: the challenges of charities in impact investing

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The social impact investment marketplace is being framed as a new, financially sustainable model for a sector impacted by dwindling donor funds and government divestment, not to mention a looming social deficit. 

This is high stakes territory. There is a lot of pressure on this area of social finance to inject large amounts of much needed private capital into our charities and nonprofits, and the recent federal government announcement of a $755 million social finance fund is intended to do just this. This pressure isn’t restricted to the Canadian context; the growth of this market has been linked to the fulfillment of the 2030 UN Sustainable Development Goals. Pope Francis has also weighed in, declaring the urgency for ‘governments throughout the world to commit themselves to promoting a market of high impact investments and thus to combating an economy which excludes and discards.’  

So what exactly is impact investment, and how does it work? Social impact investment refers to investments in charitable or nonprofit social enterprises, and social purpose businesses with the intention of producing a social or environmental impact. The loan is repaid to the investor, and possibly with a financial return.  However, since the investor expects a social impact resulting from their investment, the idea in theory is that they will tolerate a higher risk profile, and make other concessions including accepting a below-market financial return. 

The available evidence shows that the market has not yet been able to deliver on the expectations laid out by The Social Finance Taskforce and other architects of this market, in terms of injecting private funds into the sector. What has been surprising to some is that the problem appears to not be about a lack of investor interest or availability of capital, but rather that charities and nonprofits are simply not taking up this kind of investment to the extent that was predicted. The questions stands, then; if sector organizations are in need of funds, and investors are looking for social impact organizations to invest in, then what is missing here? We have undertaken research to uncover the barriers that charities and nonprofits face in accessing impact investment funds, or even entering the market. We interviewed 24 organizations - charities, nonprofits, intermediaries and charitable foundations - from two subsectors: affordable housing and community economic development (CED). We selected these areas due to the many differences between them. These were our findings:

The market can be obscure and confusing

“I’m aware of what’s available in my area, I’d say generally organizations are not. When you say ‘impact investment’, everybody has a different definition of what that is. There is no one model that people can relate to.”

It soon became clear that many individuals and market actors are operating from a variety of interpretations on what impact investment refers to. Knowledge about the market and its players was low, particularly in the CED space. Intermediaries, those organizations tasked with connecting investors to organizations, are few and too small in this country to meet the need for outreach, education, and capacity building.

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Photo courtesy of Cycle Salvation in Ottawa

Cultural differences: supply and demand have different relationships to capital

As one respondent put it, nonprofits are trained to speak the language of their donor. Fundraisers are often accustomed to emphasizing financial need for the cause, while lenders typically want to hear the very opposite of that. Rather, an organization must demonstrate financial strength, in order to keep the negotiations going.

Being able to offer security (or collateral) is integral to a securing a loan, especially when the loan is high risk (as many social enterprise ventures can be). It became clear that this was less of a challenge with housing, since a property is intrinsic to the deal, and can be offered as a guarantee if the venture proves unprofitable.  However, in community economic development, board members may be  put on the spot to offer a guarantee, and this may come down to personal assets. On top of that, volunteer board members may be unwilling to take on the fiduciary responsibility of servicing a loan. We heard cases where board members got cold feet at some point along the transaction, and kiboshed a deal put in place by staff, losing the time and resources that went into preparation (and in the meantime frustrating the loan fund).

Financial literacy is an issue

“I think a lot of folks that do this impact investment talk a language that a lot of nonprofits don’t understand. There’s certainly a gap in the financial and business knowledge between the two groups.”

It is no secret that non-profit organizations often lack the resources required to do the core work that is necessary to function.  Organizations seeking loan funding run into this barrier when the need to build capacity becomes evident – and it does. Our finding revealed that writing a business plan, valuing your program or enterprise with an investor lens, and developing your investment policy all take a certain kind of expertise that may not be available in-house. 

The market needs support

There is a real need for scaling investment opportunities and products. Investment transactions are often expensive to create and negotiate, which is a symptom of their fragmented and unique nature. To make these more affordable and accessible, there are a number of innovative projects and partnerships occurring, such as  New Market Funds, and charitable foundations are also being supportive in many ways.

With respect to federal policy, some spoke to the need for regulatory reform to better enable charities to run social enterprises, but most told us that government needs to inject capital into the market, in part to catalyze investor confidence, as well as growing intermediaries that assist charitable organizations with capacity building.

How does one evaluate a social return?

The definition of impact investing states that there must be a defined and measurable social return. We found that what constitutes a social impact is often interpreted differently, and that it is actually rarely measured due to a lack of standardized evaluation metrics. The relationship between the social and financial return, can therefore quickly become murky. Respondents differed on whether concessions needed to be made on the financial return, with one respondent arguing that without offering at least a market rate to investors, there is no prospect of bringing in new money. A different respondent, from the CED space, asked “if you’re looking for market rates of return, then why are you patting yourself on the back for doing what people do?”

Finally…

Our sector needs funds, and impact investment makes sense in our current context, where we can see the beginning of a transition from a gift economy toward investment in social outcomes. This said, we should proceed with caution: if financing depends on the measurable impact of goods and services, there is a risk that charities and nonprofits become merely service providers relatively indistinguishable from private sector ones. What do we stand to lose, and should we become accustomed to viewing charities and nonprofits primarily as vehicles for capital?

Man with hat

 

Photo courtesy of Cycle Salvation in Ottawa

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